The Mortgage Finance Bubble

While the major averages may have been relatively unchanged, things seemed
to be percolating somewhat below the surface. For the week, the Dow was slightly
negative and the S&P500 was unchanged. Economically sensitive issues performed
well, with the Transports gaining 3% (up 5% y-t-d), and the Morgan Stanley
Cyclical index up 1.5% (up 2.8% y-t-d). The Utilities added 1% and the Morgan
Stanley Consumer index was about unchanged. The broader market was stronger.
The small cap Russell 2000 jumped 3%, increasing 2004 gains to 5.5%. The S&P400
Mid-cap index gained 1.5%, with y-t-d gains of 4.8%. Technology stocks rallied,
with the NASDAQ100 up 2.3%, the Morgan Stanley High Tech index up 3.6%, and
NASDAQ Telecommunications index up 1.6%. The Semiconductors jumped 6%. The
Street.com Internet index added 2%, increasing 2004 gains to 12.6%. The Biotechs
were up 3% (up 5.6% y-t-d). Financial stocks were unimpressive, with the Broker/Dealers
and Banks about unchanged. With Bullion up $6.70 to close the week at $401.25,
the HUI Gold index added 2.5%.

Freddie Mac posted 30-year fixed mortgage rates declined 7 basis points this
week to 6.25%, the lowest rates in seven weeks. Fifteen-year fixed mortgage
rates dropped 6 basis points to 5.64%. One-year adjustable-rate mortgages could
be had at 4.13%, unchanged for the week. The Mortgage Bankers Association Purchase
application index gained 1% last week. Purchase applications were up 11% from
one year ago, with dollar volume up 22%. Refi applications rose almost 2%.
The average Purchase mortgage was for $219,000, and the average ARM was for
$295,100. ARMs accounted for 33.5% of applications last week.

The dollar index dipped about 0.25%. The Japanese yen gained 1.1%, rising
to the highest level against the dollar in more than two months. The "commodity
currencies" performed the best, with the Chilean peso up 2.1%, the Australian
dollar 1.6%, the South African rand 1.5%, and the New Zealand dollar 1.4%.

Commodities Watch:

June 23 - Bloomberg (Claudia Carpenter): "Copper futures in New York had their
biggest gain in a week on concern that the two-year decline in global inventories
shows no sign of slowing as the U.S. economy accelerates, spurring demand for
metals. Mining shares surged. Stockpiles in warehouses approved by the London
Metal Exchange fell 1.4 percent to 109,375 metric tons, the lowest since December
1996. An industry group said May 19 demand will exceed mine output through
2005, forcing metal fabricators to use more inventories... Prices are up 56
percent from a year ago..."

The CRB index was up almost 1% for the week (up 6.6% y-t-d). Hurt by a pull-back
in energy prices, the Goldman Sachs Commodities index dropped 1.5%, lowering
y-t-d gains to 12.0%.

Central Bank Watch:

June 21 - Bloomberg (Theresa Tang): "Taiwan has no urgent need to raise interest
rates as its banking system has adequate liquidity, the Commercial Times reported,
citing unidentified government officials. Taiwan may raise its rates after
the U.S. lifts its interest rates by more than 50 basis points... The island's
central bank has kept its monetary policy in step with the U.S., its second-biggest
export market, over the past four years, matching the Federal Reserve's 11
rate cuts in 2001 and the cut in June 2003."

China Watch:

June 23 - Bloomberg (Jianguo Jiang): "The average transportation cost in
China rose about a third in June from May because of rising fuel prices,
Taiwan's Commercial Times said...citing unspecified Chinese government statistics.
The cost of transporting goods rose almost 27 percent to 0.67 yuan per ton
for every kilometer of road traveled, the report said. The cost of transporting
coal rose almost 35 percent and the price of moving live poultry rose almost
27 percent in June, Commercial Times said. Surging transportation costs were
also caused by the Chinese government's crackdown on overloading, which forced
freighters to buy trucks and expand their fleet, the report said."

Asia Inflation Watch:

June 25 - Bloomberg (Heather Burke): "Major Japanese banks have increased
loans to companies in China and other parts of Asia, especially Japanese
businesses with ventures in these countries, Nikkei English News reported.
Loans to companies in China by the four major Japanese banks rose 6.3 percent...for
the year ended March 31... This growth increases more after factoring in
the yen's rise of 10 percent against the dollar... Japanese banks also have
increased credit to other Asian countries... Sumitomo Mitsui Banking Corp.'s
loans to South Korea have risen 16.8 percent and those to Thailand 6.1 percent.
Some banks plan to set up new branches in China and other Asian countries,
Nikkei said."

June 23 - Bloomberg (Lily Nonomiya and Bernard Lo): "Japanese exports rose
7.3 percent to a record in May, led by demand for cell phones and flat-panel
displays in China, helping sustain the economy's longest expansion since 1997.
Exports rose to 5.24 trillion yen ($48.2 billion) from April, seasonally adjusted,
while imports rose 1.5 percent to a record, the Ministry of Finance said in
Tokyo. The surplus widened to 1.28 trillion yen, a four-year high..."

June 25 - Bloomberg (Theresa Tang): "Taiwan's bank lending rose 10.3 percent
in May... the biggest since an 11.3 percent gain in March 1998 and marked
the ninth consecutive month of growth."

June 21 - Bloomberg (George Hsu): "Taiwanese companies' investment in China
tripled in May from a year ago as companies such as AU Optronics Corp. and
Taiwan Semiconductor Manufacturing Co. expanded their factories in the world's
seventh-largest economy."

June 24 - Bloomberg (James Peng): "Taiwan's money supply grew in May at
its fastest pace in almost five years as companies increased borrowings
to fund expansion amid surging overseas demand. M2, the broadest measure
of the island's money supply, expanded 8.6 percent from a year earlier after
growing 8.5 percent in April...That was its biggest gain since August 1999."

June 24 - Bloomberg (George Hsu): "Taiwan's export orders rose less than expected
in May as a government clampdown on industrial expansion in China cooled demand
in the island's biggest overseas market. Export orders -- indicative of shipments
in one to three months -- increased 26 percent from a year earlier to $17.3
billion after climbing 34 percent in April..."

June 25 - Bloomberg (Laurent Malespine): "Thailand's May exports rose 19.7
percent to a record, helping the nation post a monthly trade surplus of $130
million after two months of deficits, Deputy Commerce Minister Pongsak Raktapongpaisal
said... Imports rose 33 percent... Thailand, Southeast Asia's biggest economy
after Indonesia, predicts rising exports and consumer spending will help the
economy expand as much as 7 percent this year..."

June 21 - Bloomberg (Cherian Thomas): "India's exports rose 29 percent
in May as automobile companies such as Maruti Udyog Ltd. sold more cars
overseas and steel companies stepped up sales to China. Exports in May were
$5.8 billion...Imports rose 28 percent to $7.7 billion. The trade deficit
widened to $1.9 billion from $1.5 billion in May last year."

Global Reflation Watch:

June 24 - Bloomberg (Francois de Beaupuy): "French households continued to
take on a 'high' level of home loans in the first half after a record amount
of new borrowing to buy real estate last year amid rising rents and falling
interest rates, the Bank of France said. 'Distribution of new home loans should
hold at a high level in the first half of this year, given figures seen on
the residential market in the first months of 2004,' the central bank said... New
home loans rose 22 percent to 95.8 billion euros ($117 billion) in 2003,
the Bank of France said. Prices of existing homes rose 69 percent between
1997 and 2003, the Paris-based bank said..."

June 24 - Bloomberg (Simon Packard): "France's economy will probably grow
at its fastest rate since 2000 this year, the national statistics office Insee
said, predicting that demand from China and the U.S. will boost exports and
encourage corporate investment. French gross domestic product will expand 2.3
percent this year, Paris-based Insee predicted, after growth of 0.5 percent
in 2003."

June 23 - Bloomberg (Francois de Beaupuy): "France's annual inflation rate
climbed to a 12-year high of 2.8 percent in May, led by rising oil and fresh
fruit prices, a final government estimate showed."

June 21 - Bloomberg (Todd Prince): "Russia's foreign currency and gold reserves
may top $100 billion by the end of the year, Interfax reported, citing Central
Bank First Deputy Chairman Alexei Ulyukayev. Russia's reserves may grow by
$20 billion to $25 million this year, the news agency cited Ulyukayev as saying."

June 23 - Bloomberg (Nick Benequista): "Mexican exports surged 21 percent
in May from a year earlier, giving the country its first trade surplus in more
than a Year... Mexican imports rose 18 percent to $16.07 billion last month,
the release said."

June 23 - Bloomberg (Inti Landauro and Nick Benequista): "Mexico's government
raised its forecast for economic growth this year on rising U.S. demand for
Mexican goods ranging from raw metals to electronics. Mexican Finance Minister
Francisco Gil Diaz...said his government expects the economy to expand 4 percent
this year, up from a previous forecast of growth between 3 percent and 3.5
percent."

June 23 - Bloomberg (Carlos Caminada): "Brazilian banks increased lending
by the most in at least 18 months in May, a sign that the recovery in South
America's biggest economy is quickening after the central bank cut the benchmark
lending rate to a three-year low."

June 23 - Bloomberg (Carlos Caminada): "Brazil had a record current account
surplus in May as exports surged to a record high. The surplus in the current
account, the broadest measure of a country's trade in goods and services, was
$1.48 billion in May, reversing a $735 million deficit in April... The surplus,
higher than the $1.33 billion median forecast...is the biggest since the government
began keeping monthly records in 1980."

June 25 - Bloomberg (Julie Ziegler): "Argentina's economic growth reached
10 percent in the first quarter, bringing the nation closer to its output level
before the economy started to contract in 1998, the International Monetary
Fund said."

The California Association of Realtors this afternoon reported May sales data,
confirming the existence of one of history's great asset inflations. Statewide
Median Prices rose $11,550 during the month - up $36,880 over two months! -
to a record $465,160. Over the past twelve months, prices were up an astonishing
$97,530 (from $367,630), or 26%. Median prices are up 46% ($145,570) over two
years, 81% ($208,100) over three years and 129% ($262,200) over six years.
Buyers' Panic impacted statewide condo prices as well, with prices up $15,120
for the month ($33,150 for two months!) to $366,770. Condo prices were up $84,190
over the past year (29.8%), $125,580 over two years (52%), $160,320 over three
years (78%) and $208,860 over six years (132%). There was only 2.1 months inventory
of available homes for sale.

U.S. Bubble Economy Watch:

June 24 - The Wall Street Journal (Anne Marie Chaker): "College tuition will
continue its upward pace next year, but the increases at many schools will
be lower than in recent years. In Arizona, for instance, parents of resident
undergraduate students will pay a 13% to 14% increase in tuition and fees at
the state's three public universities. Last year, Arizona students faced a
39% rise in tuition and fees... This year, the average increase at state schools
will probably be somewhere between 9% and 10%, Mr. Reindl says. Last year,
tuition jumped by an average of 14%. In normal years, increases typically range
somewhere between 4% and 8%."

June 25 - Las Vegas Review-Journal (Hubble Smith): "Las Vegas home builders
pulled a record 4,501 new-home permits in May, bringing the year-to-date total
to 17,074, a 70 percent increase from a year ago... Don't expect the inventory
of new homes to grow, though, as most of those permits are already under sales
contracts, said Dennis Smith, president of Home Builders Research."

U.S. Financial Sphere Bubble Watch:

Morgan Stanley reported Net Income of $1.223 billion for the quarter ended
May 31, an increase of 104% from comparable 2003. Net Revenues were up 32%
from a year ago. Investment Banking Income was up 83% to $983 million, Principal
Transactions 24% to $2.064 billion, Commissions 24% to $877 million, and Interest & Dividends
6% to $3.663 billion. Compensation & Benefits was up 29% to $2.923 billion.
Morgan Stanley Total Assets surged a record $72.6 billion, or 44% annualized,
to $729.5 billion. Total Assets were up $126.7 billion over six months
(42% annualized) and $142.6 billion (23%) y-o-y. Total Assets were up 141%
since the beginning of 1998.

Goldman Sachs reported Net Income of $1.187 billion for the quarter ended
May 28, up 71% from the comparable period last year. Investment Banking Revenues
were up 67% from the year ago period, Trading & Principal Transactions
59%, and Asset Management & Securities Services 52%. Compensation & Benefits
were up 38% from a year ago to $2.76 billion. Goldman did not release balance
sheet data, although "assets under management increased 20% from a year ago
to a record $415 billion..."

Freddie Mac expanded its Book of Business (retained portfolio and MBS sold
into the marketplace) by $11.9 billion during May (10% annualized) to $1.444
Trillion, the strongest expansion since January. Freddie's Retained Portfolio
increased $2.4 billion (5% ann.) to $633.9 billion, the first expansion in
seven months. For the year, Freddie's Book of Business has expanded at a 4.5%
rate, with Outstanding MBS increasing at an 11.6% rate. The Retained Portfolio
has decreased at a 3.9% rate.

The Mortgage Finance Bubble

May New Homes sold at a record seasonally-adjusted annualized rate of 1.369
million units, up 15% from April and 20% above the consensus forecast. To put
these spectacular sales into perspective, New Homes sold at a rate of 534,100
during May of 1990, 517,000 during May 1991, and 554,000 during May 1992. In
fact, last month's sales were double the average for May sales during the decade
of the nineties (687,710). Sales Volumes were up 25% from one year ago, 40%
from May 2002, and 55% from May 2001. With Average Prices up 5.3% from a year
ago and Sales up 25%, annualized Calculated Transaction Value (CTV) was up
32% to $351.4 billion. CTV was up 58% from May 2002, 88% from May 2001, and
116% from May 1998. Year-to-date sales are running an amazing 22% above last
year record pace. With blistering sales volumes, the Inventory of unsold homes
dropped to a record low 3.3 months.

May Existing Homes sold at a record annualized rate of 6.8 million units,
up 15.8% from one year ago. Year-to-date, Existing Sales are running 9.5% above
comparable sales for record 2003. May sales volumes were up 20% from May 2002,
and were 60% above the average May during the nineties (4.02 million). Sales
were up 12.7% in the Northeast, 12.6% in the Midwest, 18.2% in the South, and
20.4% in the West. Average (mean) Prices rose to a record $235,500, up 10.1%
over one year and 18% over two years. Average Prices were up 13.2% in the Northeast,
4.0% in the Midwest, 10.3% in South, and 13.6% in the West. Annualized Calculated
Transaction Value (CTV) was up a notable 28% from a year ago to $1.60 Trillion
(Volume up 15.8% and Prices 10.1%). CTV was up 41% over two years (Volume up
20% and Prices up 18%), 62% over 3 years (Volume 26% and Prices 28%), and 106%
over six years (Volume up 39% and Prices up 48%). The supply of available inventory
dropped to 4.2 months, the lowest since December 2001.

Combined New & Existing Homes sold at a record pace of 8.17 million. This
was up 17.2% from May 2003, 23% from May 2002, and 30% from May 2001. Year-to-date
Combined Sales are running 11% above last year's record pace. May Combined
CTV was up 28% from one year ago to a rate of $1.953 Trillion. CTV was up 66%
from three years ago and 108% from May 1998.

CTV is an effort to quantify the value of annual home sales/ "turnover," providing
us the best indication of the general direction of mortgage Credit growth.
With CTV surging, we are clearly on our way to yet another record year of mortgage
borrowings.

Understandably, housing markets are these days the subject of much attention,
pontification, and absolutely frenetic buying interest. Reminiscent of the
late-nineties manic stock market environment, the issue "Is Housing a Bubble" has
become a hot topic for newsletter writers, journalists, policymakers and investment
analysts.

Research from the Federal Reserve Bank of New York - "Are Home Prices the
Next 'Bubble'?" proves that, despite considerable focus on the issue of asset
Bubbles, the Fed has made little progress in comprehending or addressing Bubble
dynamics. Amazingly, this report provides not a single mention of what should
be the focal points of Bubble analysis - Credit growth, loosened lending standards,
speculative psychology and finance, and marketplace liquidity.

I would aver that Fed researchers make a crucial analytical error by using
Joseph Stiglitz's definition of a Bubble:

"If the reason the price is high today is only because investors believe
that the selling price will be high tomorrow - when 'fundamental' factors
do not seem to justify such a price - then a bubble exists."

"Fundamental factors" is an analytical black hole. During the technology Bubble,
price-to-earnings ratios became the focal point of a winless "Is it or is it
not a Bubble" debate. The bears argued prices were much too high from a historical
perspective, while the bulls retorted that such valuations were justified by
stupendous earnings growth and future prospects (and low interest rates!).
The reality of the situation was that earnings were grossly inflated by unsustainable
financial flows (much of it of speculative character) that were inundating
(and distorting!) both the marketplace (the "financial sphere") and industry
("economic sphere"). Fruitful analysis would have avoided valuation and instead
focused on the dimensions and character of the surge in junk bond finance,
syndicated bank lending (especially to telecom), margin debt, hedge fund and
proprietary trading leveraging in both tech equities and debt, derivative-related
leveraging, aggressive industry vendor financings, and the general profligate
Credit environment.

As we appreciate, Asset Bubbles are Always and Everywhere a Credit Phenomenon,
and to ignore Credit and speculative dynamics is to invalidate one's research
and pontification on the subject. I won't spend a lot of time on the Fed's
research because it is clearly more propaganda (supporting chairman Greenspan's
view) than serious analysis. From the report: "Our analysis of both cash
flow affordability and a simple asset valuation model suggests that, given
the steep decline in interest rates, home prices do not appear to be at unusually
high levels. Moreover, the housing market does not appear to be driven by expectation
of rapid future price appreciation." Such conjecture is simply at odds
with the reality of the marketplace generally. The proliferation of no downpayment
mortgages, downpayment "assistance" programs, negative amortization loans,
and adjustable-rate mortgages, leaves little doubt that prices and affordability
are major issues for a large and growing number of buyers.

"Our analysis indicated that a home price bubble does not exist.
Nonetheless, home prices could fall because of deteriorating fundamentals,
and thus it is useful to gauge the magnitude of previous declines. Nationally,
nominal price declines have been rare. Moreover, real price declines - an
important consideration during this period of low inflation - have been mild.
For example, the early 1980s and early 1990s featured weak fundamentals -
slow income growth and high nominal interest rates and unemployment - yet
real home prices declined only about 5 percent."

Similar analysis of NASDAQ toward the end of 1999 would surely have been as
sanguine. Price collapses would have been seen as rare. There was certainly
an overriding perception that prices were supported by truly extraordinary
fundamentals -incredible earnings growth, low interest rates, strong economic
expansion, low inflation, and confidence in policymakers. But it is the very
defining nature of Asset Bubbles to fool the masses and their policymakers
with alluring "fundamentals." And despite the fact that Fed researchers use
low interest rates as a primary positive fundamental factor arguing against
the housing Bubble scenario, it is an economic fact of life that the greatest
Bubbles develop specifically in environments characterized by seductively low
consumer price inflation and interest rates.

"As for the likelihood of a severe drop in home prices, our examination
of historical national home prices finds no basis for concern."

Historical models would have forecasted a very low probability for a NASDAQ
collapse back in early 2000, while sound analysis of Bubble dynamics would
have proffered that the degree of excess dictated that a spectacular bust was
unavoidable (although the timing would have been much less clear).

"One reason for the moderate volatility of national home prices is that
the housing market comprises many heterogeneous regional markets."

Researchers and policymakers should tread carefully with this popular line
of reasoning. While it is true that housing markets vary by region - and by
neighborhood for that matter - housing finance is today a profoundly centralized
marketplace and more nationally homogeneous than ever. With huge national banks,
the powerful GSEs, the enormous MBS marketplace, the major national home builders,
and now the expansive Internet lenders (Countrywide!), a system has evolved
that provides basically unlimited mortgage finance and a low national lending
rate - regardless of local Credit demand.

This New Age system is having a profound - and I could argue somewhat uniform
- impact on these so-called "heterogeneous" local housing markets. How this "evolution" has
altered housing markets would make for a lengthy book. Nonetheless, it is today
flawed analysis for the Fed and pundits to mindlessly use historical experience
as a guide for the future. Extrapolating asset inflation during periods of
Acute Monetary Instability is precarious business, as was the case during the
late-twenties, the late-eighties in Japan, SE Asia during 1996, Russia during
early 1998, and NASDAQ during 1999. This is definitely the case today with
housing. Err on the side of caution.

"Our evidence thus suggests that changing demand fundamentals should cause
prices to fluctuate more in California and the northeast than in other
areas. Therefore, the strong home price appreciation over 1999-2003 in
those areas is a consequence of improving economic conditions combined
with relatively unresponsive supply. Our evidence also implies that recent
state price fluctuations can be explained through an expanded model of fundamentals."

Well, the Great California Housing Inflation over the past few years - in
the face of a notably weak economic backdrop - strongly suggests factors other
than "fundamentals" are at work. First of all, the contemporary mortgage finance
system has evolved to the point of supplying unlimited quantities of ultra-cheap
finance - Ultra-easy Credit Availability. And Bubble analysis garners us the
valuable insight that we should therefore expect the most intense inflationary
manifestations in locations presently or traditionally demonstrating the strongest
inflationary biases (including speculative impulses/"inflationary psychology").
This would certainly include markets throughout the Golden State, as well as
Greater New York, Boston, and all along the east coast. And, importantly, the
nature of the improvident mortgage finance marketplace will also ensure rampant
price gains for the most appealing properties throughout "heterogeneous" regional,
metropolitan, and neighborhood markets across the country.

Property on creeks, rivers, lakes, bays, oceans or virtually any body of water
is prone to strong inflationary gains, from coast to coast. Home prices in
the most prestigious neighborhoods will skyrocket, whether it is in Boise,
Dallas, St. Louis, or Washington D.C. And while these "heterogeneous" markets
will, of course, have varying valuations, the national Mortgage Finance Bubble
ensures that the relative prices of choice properties are all bid up to unreasonable
extremes.

Housing dynamics in Dallas provide important insights. Virtual buyers' panic
has fueled intense housing inflation in the prestigious "Park Cities" communities.
But with vast quantities of developable land in the expanding suburbs (as the
circumference of the circle enlarges), regional home price indices post only
small gains. AnecdotesI suggest similar dynamics mask the extent of inflationary
effects in communities across the country - spectacular pricing Bubbles for
the limited quantities of the most sought-after properties in favored areas,
while over-building prevails in the outlying suburbs. All the while, Fed researchers
can examine aggregate price data - especially the OFHEO series that uses only
the price-capped "conventional" mortgages that have been previously sold or
refinanced - and completely miss the essence of contemporary mortgage finance
excesses.

As I have argued for some time, the Mortgage Finance Bubble is the crucial
issue. And the evidence of historic Credit excess is anything but inconspicuous.
Over the past seven years (Q1 1997 to Q1 2004), Total Home Mortgage Debt has
surged 94% to $7.376 Trillion. Total Mortgage Debt, including commercial and
multi-family, is up over the same period by 93% to $9.618 Trillion. Looking
at the source of mortgage finance, Bank Real Estate loans have doubled in seven
years to $2.386 Trillion. Over the past 53 months (for which I have data),
combined Fannie and Freddie Books of Business have surged 78% to $3.677 Trillion.
Over the past six years, Federal Home Loan Bank Assets have surged 140% to
$857 billion.

And while the consequences of this massive inflation of Mortgage Credit are
not always obvious, there is certainly sufficient evidence to support a simple
Bubble thesis. As was noted above, over the past six years, home sales (New
and Existing) Prices have jumped about 50% and Volumes 40%. Dollar transaction
volume has doubled. But these data do not do the Mortgage Finance Bubble justice.

Total Mortgage Credit increased $1.0 Trillion last year. This compares to
the average annual increase of $206 billion during the first eight (pre-Bubble)
years of the nineties. The heart of Bubble analysis lies with the impact this
deluge of new Credit has had - and could continue having - on both the "financial
sphere" and the "economic sphere." I would strongly argue - and this is where
Bubble analysis is necessarily more an art than a science - that massive inflation
of mortgage Credit has been the instrumental fuel behind liquid financial markets,
economic expansion, and income growth. And the reason "Bubble" terminology
applies is not because home values are detached from "fundamentals," but rather
because of the dangerously self-reinforcing and inevitably unsustainable nature
of the underlying Credit expansion, asset inflation, speculative excesses and
economic maladjustment.

As mentioned above, the Fed's housing Bubble research does not mention Credit.
Nor does it address speculative holdings of mortgage-backed and agency securities,
the ballooning derivatives market, GSE exposure, the mushrooming Current Account
Deficit or the underlying structure of the U.S. economy. Yet these are the
fundamental issues that will determine the sustainability of The Great Mortgage
Finance Bubble.

With interest-rates remaining quite low and housing markets booming, the system
is poised to generate the required $1.1 Trillion plus of new mortgage Credit
this year (to sustain the financial and economic Bubbles). But with prices
being aggressively bid up in California and throughout other markets around
the country, next year will require only larger Credit growth to sustain levitated
prices, and the year after even more. And, importantly, the nature of this
type of Credit inflation will continue to foster over-consumption and severe
investment distortions within the "economic sphere." The pricing structure
of the U.S. economy becomes only less competitive, while limited"investment" spending
focuses on housing and domestic consumption and services rather than internationally
tradable goods and services. The day that the additional purchasing power associated
with $1 Trillion or so of new mortgage borrowings is not forthcoming will be
the day the system will be faced with the reality of scores of uneconomic businesses
and an enormous amount of problematic debt.

In the meantime, the "financial sphere" is faced with the specter of incessant
ballooning to finance this ongoing Credit inflation. The banking system is
performing yeoman's work in this regard so far this year, but for how long?
Prolonging the Bubble will require the resumption of GSE balance sheet ballooning,
with all eyes on the leveraged speculating community and their massive holdings
of mortgage and agency instruments. Let's keep in mind that the Fed has not
yet commenced the process of returning to more "normalized" rates. And with
funds continuing to flow to the hedge fund community, along with ongoing Wall
Street expansion, I believe at this point "de-leveraging" is more a myth than
reality. But the reversal of speculative flows and the unwind of leveraging
is an inescapable aspect of financial Bubbles - when and from what degree of
excess, not if.

And while the Mortgage Finance Bubble does possess considerable momentum today,
it remains acutely vulnerable to higher rates. The Fed is keenly aware of this
dynamic and keenly hoping to administer "Tightening Lite." And the markets
are keen that the Fed's keen, and leveraging in the U.S. Credit market is at
least as popular as ever.

But the dilemma for the Mortgage Finance Bubble at this point - that goes
completely unrecognized in Housing Bubble research and pontification - is that
there is a major foreign component involved. The requisite $1 Trillion plus
annual Mortgage Credit inflation will occasion $600 billion plus current account
deficits for the duration of the Bubble. This is assured by the nature of Dysfunctional
Monetary Processes - asset and consumption-based lending and Bubble Economy
Dynamics. And dollar balances will continue to inundate the world, and foreign
central banks will be forced to acquire/monetize these flows. As long as these
processes hold, the likely upshot will be continuing inflationary effects for
China, Asia, and economies across the globe, along with general Global Monetary
Disorder.

This week the dollar weakened against the yen, which conjures up images of
Japanese dollar support and a resumption of Treasury purchases, which conjures
up marketplace visions of stable to lower U.S. yields, which conjures up hopes
for the beloved status quo - the perpetuation of U.S. imbalances, global reflationary
dynamics and speculator nirvana. But it all does leave one wondering how high
California home prices can go; how big the primary dealer outstanding repurchase
agreement position can grow; how long the U.S. financial sector can continue
to balloon; how enormous the leveraged speculating community can become; and
how long foreign central banks, speculators and investors will play along.
Wither the dollar?

The harsh reality is that we are dealing with an historic and quite energized
Bubble, and the severity of distress and dislocation associated with the inevitable
bust will be commensurate with the degree of excess from the (out-of-control)
boom.